Buttonwood

Voting but not counting

The uneasy relationship between electors and investors

IF THE financial markets had cast all the votes, Mario Monti, Italy’s outgoing prime minister, would have romped to victory in this week’s general election. Instead ordinary Italians ranked him fourth, a long way behind a party run by a comedian, Beppe Grillo.

The relationship between markets and democracies is an uneasy one. Voters resent the idea that investors appear to have power over them—that a sell-off in the bond or currency markets can cause an economic crisis. But the way to become independent of the markets is for the government to balance its budget and for the country to avoid a trade deficit. Achieving those goals usually involves imposing the very policies that the markets favour and the voters resent.

That said, markets are fickle. For the first decade of the euro’s existence they were relaxed about Greek public spending and the potential exposure of the Irish government to its banks. They have acted a bit like a bartender who keeps serving a guest drinks in a rural bar, and then takes away his car keys on the ground that he is not fit to drive home.

Nor have investors been consistent in their recent budgetary conservatism. The prospect of America falling over the “fiscal cliff”, thereby triggering big spending cuts and tax hikes, alarmed them at the end of last year. The degree of fiscal tightening that might follow the sequester, another round of spending cuts slated to take place on March 1st, is another concern. Like St Augustine, the markets want virtue, but not yet.

The financial crisis has also highlighted the importance of a third party: central banks. After the stagflation of the 1970s, the trend in the 1980s and 1990s was for central banks to be given greater independence to set interest rates, along with an inflation target. The idea was that politicians could not be trusted with monetary policy, lest they use their power to boost their electoral chances.

The implication was that technocrats were better at running economies than elected officials. That notion has resurfaced during the euro crisis with the temporary appointments of Lucas Papademos (a former central banker) and Mr Monti (a former EU commissioner) as prime ministers of Greece and Italy respectively.

Central banks have indeed proved enormously influential, first by providing liquidity to the commercial banks and then by using quantitative easing (QE) to buy government bonds, making it easier for countries to finance their deficits. This has made their role politically controversial, with Republican leaders in Congress calling on the Federal Reserve to halt QE and with Mitt Romney, the party’s 2012 presidential candidate, declaring that he would not reappoint Ben Bernanke as Fed chairman when his term expires next year.

The European Central Bank was perceived to have saved the day last year by promising to do “whatever it takes” to save the euro, including buying government debt. Mario Draghi, the ECB’s head, clearly saw the policy as a way of giving politicians breathing space to sort out their country’s problems. Ironically, the sharp fall in Spanish and Italian bond yields since last summer has reduced the pressure on elected leaders to act. Spain has not applied for a bail-out (which would involve agreeing to an approved reform programme) and a majority of Italy’s voters felt able to plump for anti-austerity parties this week. The contrast with the second Greek election of 2012, when an air of impending crisis prompted voters to support pro-bail-out parties, is striking.

That is why some people think Italy’s economic problems will only be resolved if the markets push up the country’s borrowing costs, as they did in the immediate aftermath of the poll. “Things have to get worse before they get better,” says Richard McGuire of Rabobank, a Dutch bank.

Many argue that permanent improvement will come in Europe only if steps are taken towards a fiscal union, such as the issue of jointly-guaranteed debt. But such a solution drags you back to the difficulty of reconciling markets and voters. Voters in the creditor countries, such as Germany and the Netherlands, show little sign of wanting to make such an explicit commitment to support their southern European neighbours. Even less evidence suggests that southern European voters are willing to allow the external control of their fiscal policies that such an arrangement would imply.

Political leaders may press ahead anyway. But if voters’ views were to be of little account in determining fiscal as well as monetary policy, democracy would start to look like a sham.